ciro - the global financial crisis; triggers, responses and aftermath (2012)

The Global Financial Crisis
Tony Ciro
Triggers, Responses and Aftermath
THE GLOBAL FINANCIAL CRISIS
This page has been left blank intentionally
The Global Financial Crisis
Triggers, Responses and Aftermath
TONY CIRO
Australian Catholic University, Australia
II
Printed and bound in Great Britain by the
MPG Books Group, UK.
© Tony Ciro 2012
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system
or transmitted in any form or by any means, electronic, mechanical, photocopying, recording
or otherwise without the prior permission of the publisher.
Tony Ciro has asserted his right under the Copyright, Designs and Patents Act, 1988, to be
identied as the author of this work.
Published by
Ashgate Publishing Limited Ashgate Publishing Company
Wey Court East Suite 420
Union Road 101 Cherry Street
Farnham Burlington
Surrey, GU9 7PT VT 05401-4405
England USA
www.ashgate.com
British Library Cataloguing in Publication Data
Ciro, Tony.
The global nancial crisis : triggers, responses and aftermath.
1. Global Financial Crisis, 2008-2009. 2. Financial
crises Case studies. 3. Bank failures. 4. International

nance. 5. Economic stabilization. 6. United States
Economic policy 2001-2009. 7. United States Economic
policy 2009- 8. Structural adjustment (Economic policy)
European Union countries. 9. Financial institutions Law
and legislation. 10. International economic relations.
I. Title
330.9'0511-dc22

Library of Congress Cataloging-in-Publication Data
Ciro, Tony.
The global nancial crisis : triggers, responses and aftermath / by Tony Ciro.
p. cm.
Includes bibliographical references and index.
ISBN 978-1-4094-1139-0 (hbk) ISBN 978-1-4094-1140-6 (ebk)
1. Global Financial Crisis, 2008-2009. 2. Capital market Law and
legislation. 3. Financial services industry Law and legislation.
I. Title.
K1114.C57 2012
330.9'0511 dc23
2011045192
ISBN 9781409411390 (hbk)
ISBN 9781409411406 (ebk)
Contents
Preface vii
List of Acts and Cases ix
List of Abbreviations xi
About the Author xiii
Introduction: Timeline of the Crisis 1
1 Previous Crises 13
2 Triggers of the Crisis 33

3 The Crisis Goes Global 55
4 Financial Markets and the GFC 75
5 Rescue Packages and Policy Responses 93
6 Inquiries and Proposals for Reform 141
7 New Financial Markets Regulation 169
8 The Way Forward 207
Bibliography 219
Index 239
This page has been left blank intentionally
Preface
Writing a book is always challenging, especially when the topic is a constantly
moving target such as the global nancial crisis. The inspiration for writing the
book involved the idea of providing commentary on and analysis of one of the
most catastrophic global economic events to confront the international economy
in the modern era. Not since the 1930s Great Depression has the world witnessed
so much panic, volatility and uncertainty in international nancial and currency
markets.
In what is now described as the “Great Recession,” the millions of workers
who lost their jobs as a result of the nancial crisis demonstrate the human face of
the modern-day tragedy. The demise of Lehman Brothers was the single greatest
catalyst for the global crisis that would eventually undermine condence and trust,
even with seasoned and sophisticated investors.
Despite staging a recovery following unprecedented government and central
bank intervention, the international economy remains fragile and hostage to a
“wall of worry.” Headwinds in the form of the European sovereign debt crisis,
burgeoning US government debt and global imbalances remain and continue to
pose substantial challenges to the international recovery effort.
The Chinese proverb, “may you live in interesting times” is often described as a
curse. Whilst intended as a curse, it may well be symptomatic of the current turmoil
confronting the world’s nancial markets. Indeed, global events in the last decade

have demonstrated great upheaval, economically, socially and environmentally.
The current nancial crisis has been no different. Financial markets had become
dislocated, dysfunctional and disruptive. The global economy now needs a period
of relative calm to prevail and a return to stable economic conditions. Indeed,
nancial markets all over the world need to experience less interesting times.
Publishing with Ashgate requires the manuscript to be peer-reviewed by
experts in the eld. I am grateful for the anonymous comments made by the
reviewers that have been incorporated in the manuscript. I also want to thank
Alison Kirk from Ashgate who was thoroughly professional and provided helpful
comments and assistance along the way. I also want to thank my assistant De-anne
English-McAdams who provided valuable assistance with the preparation of the
Bibliography and Table of Contents. Last but not least, I want to thank my family,
who have always provided me with encouragement and support.
Tony Ciro
Melbourne
Australia
This page has been left blank intentionally
List of Acts and Cases
Bank Holding Company Act 1956 (US)
Banking Act 1933 (US)
Banking Act 1935 (US)
Bank Products Legal Certainty Act 2000 (US)
China Currency Manipulation Act 2008 (US)
Commodity and Futures Trading Act 1974 (US)
Commodity Exchange Act 1936 (US)
Commodity Futures Modernization Act 2000 (US)
Corporations Act 2001 (Cth)
Cuomo v Clearing House Association Case No 08-453, 129 S.Ct. 2710 (2009)
Dodd–Frank Wall Street Reform and Consumer Protection Act 2010 (Pub.L.
111–203, H.R. 4173) (US)

Economy Protection Bill 2008
Emergency Economic Stabilization Act 2008 (P.L. 110-343; H.R.1424).
Federal Deposit Insurance Reform Act 2005 (US)
Federal Reserve Act 1913 (12 U.S.C. ch. 3)
Financial Services Act 1986 (UK)
Financial Services Act 2010 (UK)
Financial Services and Markets Act 2000 (UK)
Fraud Enforcement and Recovery Act 2009 (P.L. 111-21) (US)
Futures Trading Act 1921 (US)
Gambling Act 2005 (UK)
Gaming Act 1710 (UK)
Gaming Act 1835 (UK)
Gaming Act 1845 (UK)
Gaming Act 1845 (UK)
Gaming Act 1892 (UK)
Gaming and Betting Act 1912 (NSW)
Grain Futures Act 1922 (US)
Grizewood v Blane 138 ER 578, (UK)
Hill v Wallace 259 US 44 (1922), US Supreme Court, Washington, DC
The Global Financial Crisis
x
Investment Advisers Act 1940 (US)
Investment Company Act 1940 (US)
Irwin v Williar 110 US 499 (1884)
Over-the-Counter Derivatives Markets Act 2009 (US) H.R. 3795
Private Fund Investment Advisers Registration Act 2010.
Public Law 111-21 US 2009 (USA), 111th Congress (US)
re Gieve [1899] 1 QB 794 (UK)
Securities Act 1933 (US)
Securities Exchange Act 1934 (US)

See v Cohen (1923) 33 CLR 174 (AUS)
Social Security Act 1935 (US)
Thrifty Oil Co 212 B.R. 147, 153 (Bank Reports S.D. Cal. 1997) (US Federal
Courts of Appeals)
Transnor (Bermuda) Ltd v BP N America Petroleum 738 F Supp 1472
(SDNY 1990)
Universal Stock Exchange v Strachan 40 WR 494 (UK)
Wall Street Transparency and Accountability Act 2010 (US)
List of Abbreviations
ABX Asset-backed Securities Index
AIG American International Group
AMEX American Stock Exchange
BIS Bank for International Settlements
BRIC Brazil, Russia, India and China
CBO CongressionalBudgetOfce
CBOE Chicago Board Options Exchange
CBOT Chicago Board of Trade
CDO Collateralized Debt Obligation
CDS Credit Default Swap
CEA Commodity Exchange Act 1936 (US)
CFMA Commodity Futures Modernization Act 2000 (US)
CFTA Commodity and Futures Trading Act 1974 (US)
CFTC Commodity Futures Trading Commission
CME Chicago Mercantile Exchange
CPI Consumer Price Index
DCOs Derivatives Clearing Organizations
EC European Commission
ECB European Central Bank
ECOFIN European Competition and Finance Council
EEA European Economic Area

EU European Union
FDIC Federal Deposit Insurance Corporation
FHA Federal Housing Administration
FOMC Federal Open Market Committee
FRBNY Federal Reserve Bank of New York
FSA Financial Services Authority
FSCS Financial Services Compensation Scheme
FSF Financial Stability Forum
FSOC Financial Stability Oversight Council
G8 Group of 8 Leaders Summit
The Global Financial Crisis
xii
G20 Group of 20 Finance Ministers
G30 Group of Thirty
GAPP General Accepted Accounting Principles
GDP Gross Domestic Product
GFC Global Financial Crisis
ICFS International Council for Financial Stability
ILO International Labour Organization
IMF International Monetary Fund
IOSCO International Organisation of Securities Commissions
LTCM Long-term Capital Management
MOU Memorandum of Understanding
NASDAQ NASDAQ Composite Index
NYSE New York Stock Exchange
OCC OfceofComptrolleroftheCurrency
OCR OfcialCashRATE
OFHEO OfceofFederalHousingEnterpriseOversight
OFR OfceofFinancialResearch
OFSO OfceofFinancialStabilityandOversight

OPEC Organization of Petroleum Exporting Countries
OTC Over-The-Counter
PDCF Primary Dealer Credit Facility
RBA Reserve Bank of Australia
RBI Reserve Bank of India
RBNZ Reserve Bank of New Zealand
RMBS Residential Mortgage-Backed Security
SEA Securities and Exchange Act of 1934 (US)
SEC Securities and Exchange Commission
SMDI Standard Maximum Deposit Insurance
S&P Standard and Poor’s
SMDI Standard Maximum Deposit Insurance
TARP Troubled Assets Relief Program
US Fed United States Federal Reserve
VAT Value Added Tax
About the Author
Professor Tony Ciro is the Deputy Head of School of Business (Melbourne) in the
Faculty of Business at Australian Catholic University. He is a current member of
the Victorian Bar and a member of CPA Australia. Professor Ciro is a graduate of
both Oxford University and Monash University and holds a PhD from Monash
University, a BCL from Oxford University, a Bachelor of Laws (Honours) from
Monash University and a Bachelor of Economics (Accounting & Finance)
(Honours) from Monash University. His research has been published widely in
leading Australian and international refereed journals, and has extensive research
expertise in taxation law, the global economy, nancial derivatives markets,
business law, corporation law and general commercial law.
This page has been left blank intentionally
Introduction
Timeline of the Crisis
Commentators have described the Global Financial Crisis (GFC) of the early

21st century as the greatest nancial and economic crisis the world has seen since
the Great Depression of the 1930s. Certainly, the GFC took many by surprise
as governments, investors and experienced and sophisticated market participants
were largely caught unawares by the speed and ferocity of the economic decline.
Equally disturbing were the signicant consequences that the GFC unleashed on
the world’s most developed economies.
The timeline for the GFC covered by this book stretches over the years from
2007 to early/mid-2011. This book deals with the events that led to the bursting of
the US housing bubble and the associated demise of Lehman Brothers. The book
also examines the disruption and dislocation in international credit and nancial
markets during 2008 and 2009, and goes on to examine the fallout and policy
responses relating to the nancial crisis from 2009 and to late 2011.
The GFC timeline is complicated, however, by the emergence in 2011 of a
“new” nancial crisis – the so-called “sovereign debt,” or “euro debt” crisis. As this
book goes to press, the debt crisis has not yet become a fully edged global nancial
crisis; and although the book makes reference in several places to the “ongoing’
nature of the debt crisis – particularly in relation to Greece, Ireland, Spain, Portugal
and Italy – that is associated with the GFC, it is too soon to judge how it will unfold
and whether in fact it will develop into a new global nancial crisis.
At the height of the crisis, in 2008–2009, industrial production fell rapidly and
unemployment rose dramatically. Banks led the assault on foreclosures in many towns
and cities, especially in the United States. Businesses closed their doors and banks
stopped lending. The GFC did not discriminate in its destructive nature, shattering
consumer and investor condence, undermining market sentiment and unnerving the
very fabric of economic security.
1
The GFC led to signicant and protracted decline
in industrial production in both developed and emerging economies.
However, in the period immediately preceding the GFC, world economic
growth was expanding at a brisk rate of over 4% p.a. The fast-developing nations,

which included the BRIC nations (Brazil, Russia, India and China) had been
growing at a much faster rate of between 8% and –12% p.a.
1 Nouriel Roubini and Stephen Mihm described the current nancial crisis as
a “hurricane” and a global pandemic because of its destructive and volatile nature. See
Roubini, N. and Mihm, S. Crisis Economics: A Crash Course in the Future of Finance
(New York: The Penguin Press, 2010), pp. 100–103, 115–34.
The Global Financial Crisis
2
The fast pace of growth during 2005–2007 led to record commodity prices as
global demand outstripped supply. By early 2008 crude oil prices had exceeded
$US150 a barrel and there were some who forecast that oil would soon reach
and rise beyond $US200 a barrel. Similarly, benchmark and spot prices for other
commodities, including gold, silver, iron ore, alumina, zinc, platinum and nickel,
were all pushing higher with no end in sight for bullish investors and speculators.
2
The story was the same with soft commodities in the form of wheat, cotton,
orange juice, coffee and cocoa beans, sugar and pork bellies. Even canola oil
was on an aggressive uptrend as more growers were giving up their land for
food production and replacing it with the more lucrative production of crude oil
substitutes. All of this occurred within a time frame and against a backdrop of
booming global economic conditions. For many, the global boom seemed to be
a permanent feature of a new golden age with technological advances driving
economic growth and replacing the previous boom–bust cycles with a new
dynamic economic nirvana.
The economic prosperity was heralded by governments the world over as a
new global order delivering unimaginable wealth to the industrialized nations
of the First World. The poor in emerging economies, particularly in the BRIC
nations, would also share the economic benets of the global boom. Supporters
of the new golden age claimed the economic prosperity would be sustainable and
long-lasting. The powerful and dynamic phenomenon that is globalization would

transform the lives of millions, delivering economic dividends in the form of full
employment, rises in income and improved living standards for all.
Some were also suggesting that there would be a permanent realignment of a
new world order. With previous economic booms, the developed nations of the
world took centre stage and were the main beneciaries of economic prosperity.
However, this time it was claimed that the global boom cycle would be different.
3

Through the process of globalization the benets of the new golden era of
prosperity would be shared with the less fortunate. Millions of workers in China,
India, Eastern Europe, South East Asia and South America would be transformed
from poverty to become the new middle class consumers of nished goods.
With industrialization and urbanization of the world’s most populist nations,
China and India, there would be a rebalancing of economic power and leadership.
China would be decoupled from the United States but also interlinked with it in
the complex and dynamic process which is globalization. China would also be the
new engine of global industrial production that would stimulate global growth and
2 The explosion of debt and speculation in the United States over the past 30 years
had been described as a major catalyst for the crisis. See Foster, J.B. and Magdoff, F. The
Great Financial Crisis: Causes and Consequences, Monthly Review Press, 2009, pp. 39–62.
3 In the lead-up to the Global Financial Crisis, the economic prosperity and global
boom was described in the catchcry “stronger for longer.” This was often used to justify the
realization that the current consumer and investment boom would be somewhat different to
the previous economic booms.
Timeline of the Crisis
3
deliver economic dividends to its people in the form of higher living standards,
lower unemployment and higher levels of income. In turn, the Western economies
would also benet by importing cheap manufactured goods that would help keep
ination down in otherwise high-cost Western nations.

As China developed and Westernized, growing and urbanizing its economy,
it also exported deation to Western economies. This, in turn, masked serious
risks and asset bubbles that were emerging in developed nations. With export-led
deation, interest rates in the United States, the United Kingdom, Ireland, Australia,
Spain and Portugal were kept articially low for a considerable period of time.
For a while, all of this seemed to be working as planned. Sure there were
challenges ahead, including environmental concerns, diminishing spare capacity
and high commodity prices, to name a few, but on balance everything appeared to
be manageable. World economic growth was steaming ahead, ination had been
kept in check, stock markets the world over were booming, investor and consumer
condence was at an all-time high and geopolitical tensions had eased somewhat.
Just as the world appeared to be moving along nicely, sub-prime mortgage
woes began to emerge from a number of towns and cities in the United States.
Not many fully appreciated the buildup in speculative risk that had been occurring
in the United States. Nor was it clear what would soon emerge, after all there
had been mortgage defaults and foreclosures before without serious or systemic
ramications. The US economy was also considered to be strong, robust and
sufciently advanced to be able to absorb any of the likely defaults. What began
in 2007 as some sort of isolated and containable event would soon come to trigger
the biggest economic and nancial catastrophe the world has seen since the 1930s
Great Depression.
4
The crisis sparked debate and controversy and raised a number of important
questions: What caused the crisis? Was there more than one underlying cause?
Why did the crisis occur in the rst place? Could the crisis have been averted?
How has the crisis differed from other economic crises? Why was the crisis not
readily foreseeable? What have been the main consequences owing from the
crisis? These questions, along with others, will be the topics for discussion in the
following chapters of the book.
How sub-prime mortgage defaults could trigger the global downfall was

surprising to say the least. More disturbing was the speed and scale of the decline.
The initial response from governments appeared to be ineffective in dealing with
the fallout from the crisis. World governments, central banks and regulators were
simply caught unawares, asleep at the wheel. Panic would soon replace the inept
actions of governments and central banks as the crisis deepened.
5
At its height,
4 The book by the Nobel Laureate in Economics, Paul Krugman, The Return of
Depression Economics and the Crisis of 2008 (New York: W.W. Norton, 2009), provides
similar points of comparison between the 1930s Great Depression and the current crisis.
5 According to Krugman, the wrong lessons had been learnt from previous crises
affecting Latin America. Ibid., pp. 52–5.
The Global Financial Crisis
4
the economic and nancial foundations of the world’s largest economies were
teetering on the abyss. Market regulators, central bankers and Treasury ofcials
were overwhelmed with the staggering tsunami that was to engulf the entire global
economy.
6
At the time Lehman Brothers went into bankruptcy, in September 2008, the
world was staring over a precipice, at a point of no return. Indeed, the Chairman of
the US Federal Reserve, Ben Bernanke, was quoted as saying “by Monday we will
have no economy.” The previous US Federal Reserve Chairman, Alan Greenspan,
was quoted as saying in late 2008 that in his opinion the US economy was the
worst he had seen.
7
The collapse of Lehman Brothers created a catastrophic series of events, which
gained a momentum all of its own.
8
Prior to the Lehman catastrophe considerable

debate raged as to the merits of bailing out large nancial institutions with
taxpayer money. At stake was the potential for systemic, unforeseen and unknown
interlinkages between a Lehman collapse and other parts of the nancial and
real economy, both in the United States and internationally. There was also the
inherent problem of moral hazard with the very real prospect of rewarding, instead
of sanctioning, market failure.
Moral hazard and “too big to fail” concerns came to dominate the intellectual
discourse among policymakers and regulators, including the US Federal Reserve
and the US government.
9
The arguments in favour of a Lehman bailout were
6 In testimony provided before the Senate Committee of Government Oversight and
Reform, the former US Federal Reserve Chairman described the global nancial crisis as
a “once-in-a-century credit tsunami.” Greenspan went on to say “this crisis has turned out
to be much broader than anything I could have imagined.” Greenspan 2008 (Testimony of
Dr Alan Greenspan to the Senate Committee of Government Oversight and Reform, 23
October 2008. Washington, DC: US House of Representatives), p.1.
7 “Oh, by far,” Greenspan said, when asked if the situation was the worst he had seen
in his career. “There’s no question that this is in the process of outstripping anything I’ve
seen and it still is not resolved and still has a way to go and, indeed, it will continue to be
a corrosive force until the price of homes in the United States stabilizes. That will induce
a series of events around the globe which will stabilize the

system.” See Stein, S. 2008
(Alan Greenspan: This is the worst economy I’ve ever seen. Huffpost Politics. Available at:
<ngtonpost.com/2008/09/14/greenspan-this-is-the-wor_n_126274.html>).
8 US Treasury Secretary Henry Paulson later wrote a book about his experiences in
the days, weeks and months in the lead-up to Lehman’s collapse. According to Paulson, the
reaction of the market to the collapse of Bear Stearns, AIG and Lehman was nothing short
of panic, chaos and in locked down mode. See Paulson 2010a (Paulson, H.M. 2010a. On

the Brink: Inside the Race to Stop the Collapse of the Global Financial System. New York:
Business Plus, Hachette Book Group), pp. 246–8.
9 See A.R. Sorkin’s account of the raging debate and the tug of war between US
federal regulators, including the US Federal Reserve, the US Treasury Secretary, the
Securities and Exchange Commission, and representatives from Lehman Brothers and AIG:
Sorkin, A.R. Too Big To Fail (London: Viking Penguin, 2009), pp. 216–21.
Timeline of the Crisis
5
persuasive. Equally compelling was the notion of moral hazard and letting losses
lie where they fall. Ultimately, history will show that Lehman Brothers did in fact
go into bankruptcy with no bailout protection provided to its stakeholders. There is
continuing controversy regarding the fate of Lehman Brothers. Senior management
gures remain convinced that Lehman was salvageable and was a victim of the
prevailing market sentiment at the time of its demise. Senior policymakers and
regulators in the United States have been less sympathetic to this contention and
have laid blame directly at the inherent riskiness of Lehman’s business model.
Whatever the true nature of the allegations surrounding Lehman’s nancial
health and wellbeing, the demise of the company wrought havoc in nancial
markets all over the world. The collapse of Lehman Brothers in late 2008 could
not have come at a worse time for investor and market condence.
As nancial markets seized up, stock markets collapsed and credit markets
froze, concerns were mounting that the world was in the midst of another Great
Depression.
10
At the beginning of 2009, the crisis that began in nancial markets
soon swamped the real economy. Industrial production in most countries fell, with
developed nations leading the dramatic declines. Even the formerly dominant
BRIC economies could not withstand the economic tsunami that was engulng the
world. Investors and markets soon came to the realization that there was no safe
harbour. The so-called “decoupled” economies of China, India, Russia, Canada,

Brazil and Australia were all adversely affected.
The crisis which had its genesis in the US sub-prime mortgage market
spilled over to wreak havoc in the real economy. Industrial production declined
substantially as banks withdrew their lending and credit markets froze. GDP in
almost all developed countries also began to decline which, in turn, led to a rapid
acceleration in the level of unemployment. Workers were laid off at an alarming
rate and the “bubble” economies – the United States, Ireland, Spain, the United
Kingdom and Portugal – suffered the most, since they were the main beneciaries
of escalating house prices in the boom period.
Structure of the Book
There has been conjecture as to whether asset bubbles caused, or at the very
least triggered, the current crisis.
11
The residential housing bubble in the United
States was at the centre of the sub-prime mortgage crisis that later spread to the
10 According to Paulson, President George Bush asked whether the current crisis was
the worst since the Great Depression, to which the US Federal Reserve Chairman, Ben S.
Bernanke, replied in the afrmative and added that the current crisis could even become
much worse. Ibid. (n. 8), pp. 255–6.
11 The prominent economist and Nobel Laureate for Economics, Joseph Stiglitz,
draws an analogy of the causes of the current crisis with the crime of murder, and posits
the question: The anatomy of a murder: Who killed America’s economy? See Friedman, J.
The Global Financial Crisis
6
mainstream housing market, which, in turn, later spread to nancial markets. As
Chapter 1 explains, bubbles have been around for centuries. An asset bubble,
whether it is an overvalued stock market, an overheated housing market, or
unsustainable commodity prices, will eventually be deated. However, the crucial
issue with a deating bubble is whether the economy will be exposed to a soft or
a hard landing.

History has demonstrated that with the demise of an asset bubble an economic
recession is not always inevitable. There have been asset bubbles in the past
which have been allowed to deate and have not led to an economic recession.
Some bubbles can be isolated, one-off events which have little or no systemic
consequences. However, history has also demonstrated that some bubbles that do
deate can lead to signicant economic contractions. Whether a soft or a hard
landing will occur is often difcult to predict. The recent crisis proves that even
when economic conditions appear to be favourable, events can occur which lead
to rapid and unpredictable changes in fortune.
As Chapter 2 demonstrates, the precise causes of the recent crisis are still subject
to debate. The causes may be described less as causes and more appropriately
as triggers. It is often difcult to determine whether there are direct and clear
causal factors in an economic crisis. Sometimes, prevailing economic conditions
can exacerbate an already weak or slowing economy. Hence, deterioration in the
overall economic climate can heighten existing problems or alternatively, make of
something a problem where one did not originally exist.
The analogy here is the famed evolutionary conundrum – the chicken and egg
analogy and the origins of life. Scientists have mulled over this issue for years.
Why would it be any different for economists? What caused the recent crisis may
well be less of an issue, however important the question may be. This is because
one singular event viewed in isolation may not lead to any noticeable adverse
change. However, when taken in its totality, along with the prevailing economic
environment, the cause or causes can develop a life of their own. A cause or a
trigger can at times be problematic but not necessarily lead to major economic
damage. This is because certain triggers can be fairly isolated non-events and not
capable of producing long-term systemic consequences.
The focus of much of the current debate has been on asset bubbles and the
dangers that they pose to the real economy. The housing bubble in recent times
has been the source of much of the current analysis. This is especially the case in
the United States, the United Kingdom, Ireland, Spain and Portugal, where house

prices rose quite dramatically in the lead-up to the global crisis. As the crisis took
hold, these countries, which enjoyed the stimulus provided by the housing and
construction boom, witnessed severe economic contractions when houses prices
began to decline.
What Caused the Financial Crisis? (Philadelphia: University of Pennsylvania Press, 2011),
pp. 139–49.
Timeline of the Crisis
7
However, in other countries house prices have not declined but, rather, have
remained relatively robust. An example of this phenomenon is Australia, where
not only have house prices not declined but instead reportedly rose a hefty 20%
or more in capital cities across Australia in 2009–2010.
12
One major explanation
for Australian house prices bucking the world trend was the fact that Australia
avoided a recession in 2009, whilst much of the Western world recorded substantial
declines in industrial production and GDP. With a relatively robust economy,
house prices in Australia did not suffer the same fate as the rest of the world.
Despite this, a number of commentators have argued that a housing bubble has
formed in Australia and house prices will decline over time.
13
Whatever may be the case for asset price bubbles, regulators have become
increasingly uneasy and are now more likely to aggressively target speculative
and excessively risky activity. The problem for regulators is: how do they go about
deating asset bubbles that have already formed without engineering a slowdown
in the wider economy? The weapon of choice for central bankers is monetary
policy. Through the use of restrictive monetary policy, monetary regulators can
try to deate asset bubbles before they lead to unforeseen consequences for the
real economy. As is discussed in Chapter 5, the main problem with using interest
rates to control asset prices lies with the very fact that monetary policy is a blunt

instrument, which can have adverse ramications for other parts of the economy.
14
Other commentators have suggested that alternative and less draconian policy
measures should be used to control asset prices. Instead of using restrictive
monetary policy, which has as its central control of consumer prices, asset prices
and speculation could be controlled through prudential regulation. The use of
supervisory oversight by monetary regulators as well as other nancial market
regulators could provide effective management and containment of speculators
12 The Real Estate Institute of Victoria (REIV) reported a 26.8% rise in Melbourne
house prices between 2009 and 2010. See <
=1048&nav1=652&nav2=165>.
13 One of the most avid critics of the Australian property market is Professor
Steve Keen, who has argued that a debt bubble has emerged in the Australian residential
property market and hence, over time, house prices in Australia will need to fall to restore
equilibrium. See <tdeation.com/blogs/>.
14 According to Ben Bernanke in a speech delivered in January 2010, “Economists
have pointed out the practical problems with using monetary policy to pop asset price
bubbles, and many

of these were illustrated by the recent episode. Although the house price
bubble appears obvious in retrospect – all bubbles appear obvious in retrospect – in its
earlier

stages, economists differed considerably about whether the increase in house prices
was sustainable; or, if it was a bubble, whether the bubble was national or conned to a few
local markets. Monetary policy is also a blunt tool, and interest rate increases in 2003 or
2004 sufcient to constrain the bubble could have seriously weakened the economy at just
the time when the recovery from the previous recession was becoming established.” See
Bernanke 2010b (Monetary policy and the housing bubble. Speech at the Annual Meeting
of the American Economic Association, Atlanta, Georgia, 3 January 2010).

The Global Financial Crisis
8
without subjecting the broader economy to the ill effects of restrictive monetary
policy. The current Chairman of the US Federal Reserve, Ben Bernanke, favours
robust prudential or supervisory regulation to deal with asset bubbles rather than
restrictive monetary policy.
15
However, Bernanke did keep open the option of
using monetary policy to deate asset bubbles if prudential regulation proved to
be ineffective.
16
As Chapter 3 illustrates, the recent crisis has been a truly global phenomenon.
The speed, ferocity and systemic nature of the crisis proved that the world had
become even more interlinked than was previously thought. Globalized nancial
markets created the almost perfect transformation of a largely US domestic crisis
into a full-blown international tsunami of biblical proportions. The transmission of
a domestic problem to the international stage has occurred in the past.
Economic history tells us that adverse events that plague small nations can
undermine condence and security in much larger economies. This has been
illustrated in recent times with the sovereign debt crisis involving Greece, which
has led to a run on the euro and has spread risk to other countries. Does this mean
that investors are irrational? Or does it mean that investors have become extremely
risk-averse in times of heightened uncertainty? These issues are explored in
detail in Chapter 4. Investor behaviour and the markets’ response to the crisis
provide important clues as to why the crisis became so pervasive and destructive
to the global economy. Almost overnight nancial markets ceased to function in
a rational and orderly manner. To borrow a phrase from the former US Federal
Reserve Chairman, the demise of Lehman Brothers contributed greatly to the
“irrational exuberance” of nancial markets.
There remains considerable conjecture as to the appropriate role of regulators

in a market-driven economy. This debate continues to rage and is the focus for
discussion in Chapter 5. There is widespread belief that enhanced regulation
would be of signicant benet to nancial market participants as well as to the
broader community. Prior to the European debt crisis, attention was focused on
the relatively weakened state of nancial and banking regulation that existed in
the United States. The collapse and subsequent bailouts of mortgage originators
15 Bernanke stated: “That conclusion suggests that the best response to the housing
bubble would have been regulatory, not monetary. Stronger regulation and supervision
aimed at problems with underwriting practices and lenders’ risk management would have
been a more effective and surgical approach to constraining the housing bubble than a
general increase in interest rates. Moreover, regulators, supervisors, and the private sector
could have more effectively addressed building risk concentrations and inadequate risk-
management practices without necessarily having had to make a judgment about the
sustainability of house price increases.” Ibid
.
16 Bernanke stated: “However, if adequate reforms are not made, or if they are made
but prove insufcient to prevent dangerous buildups of nancial risks, we must remain open
to using monetary policy as a supplementary tool for addressing those risks – proceeding
cautiously and always keeping in mind the inherent difculties of that approach.” Ibid.
Timeline of the Crisis
9
Freddie Mac and Fannie Mae, investment bank Bear Stearns, and AIG, all pointed
to market failure and ineffective regulation.
17
Not since the Great Depression had there been a colossal failure of condence
and trust by investors, nancial market participants, banks, credit providers
and equity and credit markets. For the rst time since the 1930s the collapse in
condence represented a synchronized and systemic failure in all things nancial
and economic. Why did nancial markets fail so spectacularly? Why did credit
markets seize up in 2008? What were the causes of the unprecedented market

volatility? Why had fear gripped equity markets the world over? What could
regulators have done to prevent, or at least, minimize the downside risks? Could
enhanced regulation and supervisory oversight over banks and nancial markets
have prevented much of the crisis? These questions along with others will be
explored in Chapter 5.
In Chapter 6 rescue packages, including taxpayer-sponsored bailout measures,
which were deployed by various governments, central banks and other regulatory
authorities, will be examined. The bailouts have been costly and were not without
controversy. At the height of the crisis, it was estimated that the nancial damage
to the US economy would run into the hundreds of billions of dollars. The overall
world economy would be $US3 trillion worse off. In 2008 the US government
announced a $US700 billion bailout package designed to prevent any further bank
failures. George W. Bush, in one of his last acts as President of the United States,
signed the Emergency Economic Stabilization Act of 2008, commonly called the
Troubled Assets Relief Program (TARP), into law.
18
In addition to the TARP program in the United States, the European Union in
2010 enacted a similar program to help stabilize the Greek economy and provide
support to the plunging euro. After initially resisting moves to support the Greek
economy, European nance ministers were forced to act when international
currency markets began to react adversely and devalue the euro. Sensing that a
run on the euro could unnerve already volatile equity and currency markets, and
put at risk a fragile recovery, the Council of the European Union Member States
and the International Monetary Fund agreed to a €750 billion nancial stability
package.
In a press release issued by the Council of the European Union, the EU
concluded that “The Council and the Member States have decided today on a
17 Kroszner and Shiller argue, as a major lesson to be learnt from the current crisis,
for reforms to be made to United States nancial markets which should be designed to
make the markets more robust. See Kroszner, R.S. and Shiller, R.J. Reforming US Financial

Markets: Reections Before and Beyond Dodd-Frank (Cambridge, MA: The MIT Press,
2009), pp. 51–81.
18 Although there had been considerable disagreement concerning the merits of
taxpayer-funded bailouts, the Bill was passed by the US Senate on 1 October 2008 and the
House of Representatives passed the nal version of the Bill on 3 October 2008. See the
Emergency Economic Stabilization Act 2008 (Pub.L. 110–343); H.R.1424.
The Global Financial Crisis
10
comprehensive package of measures to preserve nancial stability in Europe,
including the European Financial Stability mechanism….”
19
The ambitious nancial stability package was justied on the basis of
investors’ perceptions that underlying structural weaknesses existed in some key
member states, including Portugal, Italy, Ireland, Spain and Greece. The Council
of the European Union was of the view that continued uncertainty and volatility in
nancial and currency markets would undermining condence in the euro, which
in turn could lead to systemic risk in the European Union: “In the wake of the
crisis in Greece, the situation in nancial markets is fragile and there was a risk
of contagion, which we needed to address. We have therefore taken the nal steps
of the support package for Greece, the establishment of a European stabilization
mechanism and a strong commitment to accelerated scal consolidation, where
warranted.”
20
As is discussed in Chapter 7, the controversy stirred by the bailout packages
was fuelled in part by the public’s negative perception of Wall Street executives.
There was little sympathy on Main Street with taxpayer funds being used to bail
out banks, mortgage originators and investment rms. This was especially the
case when a number of small- to medium-sized enterprises were experiencing
extreme difculties in accessing lines of credit which were crucial in day-to-day
operations. The banks, in turn, had their own difculties in funding their retail

lending books because following the collapse of Lehman Brothers, bank access to
international wholesale debt and credit markets had been restricted.
The nancial crisis later caused damage to the real economy when much of
the international economy was forced into recession. This was made evident by
signicant declines in industrial production and GDP, along with the simultaneous
dramatic increase in unemployment all over the world. Fearing another Great
Depression, governments responded with aggressive stimulus packages, which
were designed to overcome the gap in private sector expenditures.
However, the large increases in stimulus brought forward a new crisis, namely
one involving scal decits and sovereign risk. As is discussed in Chapter 7, the
recent sovereign risk debt crisis was most acute in Europe, particularly for Greece,
Portugal and Ireland. Other European countries, including Italy and Spain,
continue to cause consternation amongst investors and bondholders.
As the mood shifted away from the ill effects of private household debt and
commercial borrowings, sovereign debt became the new issue for investors to
focus upon. And focus they did. Financial markets and currency speculators had
become obsessed with the overall stability of the euro. All of a sudden the euro,
which had earlier become the beacon of stability and a possible candidate for the
world’s reserve currency, was placed under the proverbial spotlight. It was argued
19 European Union Council. 2010. (Extraordinary Council Meeting on Economic
and Financial Affairs. Press release 108 (9596/10), 9/10 May 2010. Brussels: Council of
the European Union), p. 6.
20 Ibid.